California Court: Leasing Employers and Temporary Service Employers May Not Self-Insure

Earlier this month, a California appellate court struck down a challenge by two staffing companies that had sued the state, alleging that Cal. Lab. Code § 3701.9, added in 2012 as part of Senate Bill No. 863, and which prohibits leasing employers (LEs) and temporary service employers (TSEs) from self-insuring, was unconstitutional on equal protection grounds [Kimco Staffing Servs., Inc. v. State of Cal., 2015 Cal. App. LEXIS 394 (May 8, 2015)]. Prior to the adoption of the statute by the California legislature, the two firms had participated in the California workers’ compensation self-insurance program. The firms alleged in relevant part that § 3701.9 was invalid because it singled out LEs and TSEs and prohibited them from participating in the state’s self-insurance program. The firms further alleged that § 3701.9 “treats similarly situated entities differently and arbitrarily, and irrationally distinguishes between them.”

Initially noting that a statute, once duly enacted, was presumed to be constitutional and that any doubts would be resolved in favor of the statute’s validity, the Court concluded that a rational basis existed for treating LEs and TSEs differently from other employers with respect to self-insurance. The Court observed that the core business model utilized by LEs and TSEs was quite different from most other firms, that unlike traditional or worksite employers, which only hire employees consistent with their business needs, LEs and TSEs were in the business of providing employees to other businesses. Further, they had a clear “incentive to add new clients” and to expand their payrolls. The scope of their workers’ compensation risk could dramatically change during the course of a year, as the firms took on new clients and added employees to their payroll. While the payroll of an LE or TSE might grow rapidly during a calendar year, the company’s self-insurance deposit would not be adjusted until the subsequent year.

The Court agreed with the trial court’s finding that the Legislature reasonably could have concluded that the annual method of determining the self-insured security deposit based on the self-insured’s projected losses and liabilities calculated as of December 31 of each year (§ 3701(c)) was inadequate to account for a potential exponential increase in risk during a calendar year, notwithstanding the Department of Industrial Relation’s ability to audit and adjust security deposits. Thus, a rational basis existed for treating LEs and TSEs differently from other employers with respect to self-insurance (for additional discussion, see Larson’s Workers’ Compensation Law, § 150.01[2]).